Enterprise Value-to-Sales – EV/Sales

What Is Enterprise Value-to-Sales – EV/Sales?

Enterprise value-to-sales (EV/sales) is a financial valuation measure that compares the enterprise value (EV) of a company to its annual sales. The EV/sales multiple gives investors a quantifiable metric of how to value a company based on its sales, while taking account of both the company's equity and debt.

The Formula for Enterprise Value-to-Sales

EV/Sales = MC + D − CC Annual Sales where: MC = Market capitalization D = Debt CC = Cash and cash equivalents \begin{aligned} &\text{EV/Sales} = \frac{ \text{MC} + \text{D} - \text{CC} }{ \text{Annual Sales} } \\ &\textbf{where:}\\ &\text{MC} = \text{Market capitalization} \\ &\text{D} = \text{Debt} \\ &\text{CC} = \text{Cash and cash equivalents} \\ \end{aligned} EV/Sales=Annual SalesMC+D−CCwhere:MC=Market capitalizationD=DebtCC=Cash and cash equivalents

How to Calculate Enterprise Value-to-Sales

Enterprise value-to-sales is calculated by:

1. Adding total debt to a company’s market cap
2. Subtracting out cash and cash equivalents
3. And then dividing the result by the company’s annual sales

A slightly more complicated version of enterprise value with a few more variables is sometimes used. The more complex formula for EV is:

EV = MC + D + PS + MI − CC where: PS = Preferred shares MI = Minority interest \begin{aligned} &\text{EV} = \text{MC} + \text{D} + \text{PS} + \text{MI} - \text{CC} \\ &\textbf{where:}\\ &\text{PS} = \text{Preferred shares} \\ &\text{MI} = \text{Minority interest} \\ \end{aligned} EV=MC+D+PS+MI−CCwhere:PS=Preferred sharesMI=Minority interest

What Does Enterprise Value-to-Sales Tell You?

Enterprise value-to-sales is an expansion of the price-to-sales (P/S) valuation, which uses market capitalization instead of enterprise value. It is perceived to be more accurate than P/S, in part, because the market capitalization alone does not take a company's debt into account when valuing the company, while enterprise value does.

EV-to-sales multiples are usually found to be between 1x and 3x. Generally, a lower EV/sales multiple will indicate that a company may be more attractive or undervalued in the market. The EV/sales measure can also be negative when the cash balance of the company is greater than the market capitalization and debt structure, signaling that the company can essentially be bought with its own cash.

The EV-to-sales measure can, however, be slightly deceptive in that a higher multiple is not always a signal of over-valuation. A high EV-to-sales can be a positive sign that investors believe that future sales will greatly increase. A lower EV-to-sales can likewise signal that future sales prospects are not very attractive.

To make the most out of this metric, compare the EV-to-sales to that of other companies in the same industry, and look deeper into the company you are analyzing.

Example of How to Use Enterprise Value-to-Sales

Assume that a company reports sales for the year of $70 million. The company has $10 million of short-term liabilities on the books and $25 million of long-term liabilities. It has $90 million worth of assets, with 20% of that in cash. Lastly, the company has 5 million shares of common stock outstanding and the current price of the stock is $25 per share. Using this scenario, the company's enterprise value is:

EV = Market Cap (5 Million Shares × $25 Stock Price) + Total Debt ($10 Million + $25 Million) − Cash ($90 Million × 2 0 % ) = $ 1 2 5  Million + $ 3 5  Million − $ 1 8  Million \begin{aligned} \text{EV} &= \text{Market Cap (5 Million Shares} \times \text{\$25 Stock Price)} \\ &\quad + \text{Total Debt (\$10 Million} + \text{\$25 Million)} \\ &\quad - \text{Cash (\$90 Million} \times 20\%) \\ &= \$125 \text{ Million} + \$35 \text{ Million} - \$18 \text{ Million} \\ &= \$142 \text{ Million} \end{aligned} EV=Market Cap (5 Million Shares×$25 Stock Price)+Total Debt ($10 Million+$25 Million)−Cash ($90 Million×20%)=$125 Million+$35 Million−$18 Million

Next, to find the EV-to-sales, simply divide the calculated enterprise value by sales. In this example, the EV-to-sales is:

EV/Sales = $ 1 4 2  Million $ 7 0  Million = 2 . 0 3 \begin{aligned} &\text{EV/Sales} = \frac{ \$142 \text{ Million} }{ \$70 \text{ Million} } = 2.03 \\ \end{aligned} EV/Sales=$70 Million$142 Million=2.03

Taking the EV/sales ratio a step further, consider Coca-Cola. The company has a market cap of $237 billion as of Dec. 31, 2019.

EV/sales = 7.3x, or $273.3 billion / $37.2 billion.

Enterprise Value-to-Sales vs. Price-to-Sales

The EV-to-sales ratio takes into account the debt and cash a company has. The price-to-sales ratio, meanwhile, does not. The price-to-sales ratio is quicker to calculate, using only a company’s market cap as the numerator. However, debtholders do have a claim on sales and should theoretically be included in the valuation.

Limitations of Using Enterprise Value-to-Sales

The EV/sales ratio requires calculating the enterprise value, which involves a little more digging into financial statements. EV is generally used for valuing acquisitions, where the acquirer will assume the debt of the company, but also get the cash. Another limitation to be aware of is that sales do not take into account a company’s expenses or taxes.